This article is sponsored by EcoAct.
When the industrial revolution was changing the world in the 1800s, the Fords, Carnegies and Rockefellers likely could not have envisioned a market in which carbon was certified, audited and traded. The carbon market began as a results-based market mechanism that acknowledged the necessity of economic incentives for nations to curb emissions and incentivize low-carbon development. Carbon markets have evolved into a significant international market segment that has generated $104 billion in revenue in 2024 — across carbon taxes, emissions trading systems (ETSs) and crediting mechanisms — to fund climate and nature programs.
Way back at COP3 in 1997, the United Nations Framework Convention on Climate Change unveiled this emissions trading framework, the Clean Development Mechanism, allowing industrialized nations a certain degree of flexibility in meeting their emission reduction commitments while simultaneously financing the implementation of carbon reduction projects in developing nations. The overarching goals were to share the responsibility among more industrialized nations in incentivizing the trajectory of a low-carbon economy as developing countries grew. At COP26 in 2021, the Voluntary Carbon Markets Integrity Initiative (VCMI) was introduced and has become a crucial instrument guiding corporations towards the responsible use of carbon credits.
Today, the energy transition and the race to net zero is entering a new phase of maturity in which nations and corporations are being held to higher levels of integrity in both compliance and voluntary carbon offset claims, reporting and data.
Voluntary carbon markets drive innovation
The global voluntary carbon market value (VCM) was only $723 million in 2023. Its price coverage and levels remain too low to meet today’s global decarbonization goals, as this market covers numerous project types, broadly covering nature and technology-based projects. Still, given the size of the VCM, it’s amazing how much innovation has already happened. Biogas, wind and solar are among the ingenious technologies that have scaled significantly and hit the global “mainstream” thanks in part to carbon markets. Community-based projects, such as household biogas, efficient cookstoves and water purification, have scaled to unprecedented levels thanks to the carbon credit financing, providing social, economic and environmental benefits to lower-income communities in some of the least developed countries.
Most notably, in developing energy countries such as India — where wind, solar and other renewables projects were once written off as infeasible due to costs — the VCM has opened up funding that has made renewables projects viable and has dramatically reduced the number of regions that are “priced out” of renewables.
Now, there is similar hope that carbon credits can help to do the same for cutting-edge — but cost-intensive — carbon-capture technologies that physically remove carbon dioxide from the environment, or through the restoration of ecosystems such as by improved forest management. Where grant and aid programs historically supported the financing of initiatives focused on low-income communities and developing countries, the VCM has stepped in to provide additional revenue streams, while also ensuring a minimum standard of transparency on measurement, reporting and verification (MRV) is consistently required to ensure integrity. While issues remain, the VCM has opened the door to knowledge transfer and the development of a market where funding is no longer dependent on a single entity.
Transition time for carbon markets
There has been much deliberation on the efficacy and integrity of carbon markets. Naturally, there is skepticism over how accurate carbon reduction estimates from projects actually are, and fears over disingenuous players gaming the system to earn a license to operate — or pollute — are still very real. As in other emerging markets, bad actors take advantage of a system that is a work in progress and is defined by myriad fragmented regulatory guardrails, inexact standards and imprecise data. These instances of bad actors can take precedence in the press, unfortunately drowning out many positive environmental, social and economic outcomes that the vast majority are creating on the ground.
Increased focus and investment in this area is essential to ensure corporations can feel confident in the accounting, and other stakeholders can trust the integrity of the market. Many corporations are waiting for more defined regulatory frameworks before they integrate carbon offsets into their net zero strategies, which are initiatives that require significant consideration in terms of alignment with strategy, buy-in and commitment. As policymakers install the guardrails that solidify market credibility, more corporations will get in the game. Fortunately, this state of play is being recognized, and noticeable efforts are being made to create standardization, and to make accounting methodologies more advanced and requirements more robust.
Carbon offsets credibility quotient
- In May, the United States released a directive to codify the government’s approach to advance high-integrity VCMs, noting that “VCMs have reached an inflection point.”
- In 2023, the U.S. Commodities Futures Trading Commission and the Federal Trade Commission said they were ramping up enforcement efforts against carbon trading fraud.
- California’s Voluntary Carbon Market Disclosures Business Regulation Act became law Jan. 1.
- March’s long-awaited SEC rule included requirements for companies to incorporate climate-related disclosures, including the use of carbon credits, in annual financial reports and other filings.
- The European Parliament formally approved establishing the world’s first voluntary certification framework for carbon removals, CRCF, boosting the EU’s capacity to quantify, monitor and verify such activities to counter greenwashing.
- At COP28, the world’s leading independent carbon crediting standard-makers declared they will start working together to improve consistency, transparency and quality across the carbon project certification landscape.
- The World Bank reported that there are 75 carbon pricing instruments in operation worldwide.
- The Innovation Fund doled out a $4.35 billion budget in 2023 to support the deployment of innovative clean technologies using revenues from the EU Emissions Trading System (ETS).
While Scope 3 emission assessments generally rely on estimations, integrity is increasing thanks to the improved MRV regime, refinement of methodology, satellite data, etc. To be deemed credible, carbon credits must already meet the criteria and are subject to rigorous additionality tests and third-party auditing before being certified. Universal standards are inevitable. Tailwinds in the form of rulemaking, technology and data improvements in aid of supply-demand integrity herald an expansion of carbon markets.
Carbon as a hot commodity
Carbon credits are not created equal in terms of quality and integrity. This is when credible credits take a backseat to quality credits. For example, carbon credits, which are nature-based, not only deliver positive climate impact, but also support broader nature and biodiversity objectives — and do not harm the environment. In 2024, prices are on the rise, but the supply of high-quality offsetting projects struggles to meet the surging demand, challenging companies to select appropriate projects that align with their sustainability goals. The emergence of Moody’s-style carbon ratings (AAA through D) agencies such as BeZero is another promising signal that the carbon markets are poised to grow. As such, quality credits command a price premium, as A-rated credits’ prices have risen by around 200 percent.
Carbon crediting mechanisms
Meanwhile, international, governmental and independent carbon crediting mechanisms have solidified their roles in enabling countries or companies, for which “the cost of reducing emissions is high, to pay low-cost emitters for carbon credits that they can use towards meeting their emission-reduction obligations, or for voluntary or trading purposes.” One such project involves Microsoft and one of the world’s largest timberland managers, BTG Pactual Timberland Investment Group, which entered into the largest carbon dioxide removal transaction on record, with Microsoft committing to buy 8 million carbon removal credits. The credits will propel BTG’s $1 billion strategy to protect and restore natural forests in deforested landscapes in South America. These transactions are aligned with one of the top priorities in the U.S.’s released principles for integrity in VCMs, focused on assisting farmers and forest landowners.
Another critical market segment is aviation, for which Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) is aiming to decarbonize air travel and transport. Instead of a government crediting mechanism, this case features an international agency driving the project, the United Nations. Airlines are required to purchase carbon credits to offset CO2 emissions that cannot be mitigated through technological advancements, operational improvements or sustainable aviation fuels.
Maximize the value of carbon credits
Sustainable transformations require the alignment of business models with planetary boundaries — and need to encompass economic, social and environmental dimensions to enable a just transition. Our research estimates that carbon price costs could account for 10 percent of the revenue of carbon-intensive sectors by 2030, so these industries must diligently manage the financial risk. Even now, numerous market forces are acting on the carbon market value and prices. The total value of the voluntary carbon markets slipped from $1.9 billion in 2022 down to just over $700 million in 2023, although it had dropped for two consecutive years. This was due to lower supply, with standards bodies struggling to meet demand for project reviews, integrity standards still gaining traction such as with Integrity Council for the Voluntary Carbon Market (ICVCM) recognizing only a fraction of carbon offsets, and the buyer focus on removals, which make up less than 5 percent of issued carbon credits. Furthermore, updated methodology reviews have created a lag in issuing carbon offsets as the VCM retools to satisfy what the buyer market is demanding today in terms of “quality.”
Corporations trading in offsetting credits that develop an earlier understanding of carbon pricing dynamics can start benefiting from carbon management projects ahead of competitors. Furthermore, there is greater confidence than ever being built on both sides of the market thanks to the ICVCM and The Voluntary Carbon Markets Integrity Initiative, ensuring that markets are being used responsibly and that money is being allocated to the areas of greatest impact.
Inflection points toward a scaled carbon market
Even though the agreement on Article 6 of the Paris Climate Agreement’s crediting mechanism was tabled until this year’s COP29, its operationalization seems inevitable, because it will enable countries to transfer carbon credits earned from the reduction of greenhouse gas emissions to help one or more countries meet their climate targets.
Carbon markets are merely one strategy for mitigating climate risk, although an essential one. Their growth is accelerating the scale of numerous technologies that will propel the energy transition, such as direct air capture, biochar and blue carbon. By the same token, the proliferation of new technologies is also driving carbon markets’ growth. These developments are bolstering clarity, transparency and standardization in carbon market measurement, setting the stage for expansion and ultimately normalization.
